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The Impact of the Energy Profits Levy (windfall tax)

James McCallum, Xergy GroupJune 20, 2022
Energy Sector Challenges
windfall tax

A one-off tax devised to redirect windfall profits from oil and gas companies to UK households struggling with soaring energy bills has provoked mixed reactions. We look at what Rishi Sunak’s Energy Profits Levy (‘windfall tax’) means for sector investment and net zero commitments

What is the windfall tax? 

So, what is this one-off “additional tax which reflects the extraordinary global context”?

Put simply, the Energy Profits Levy is a tax on the excess profits enjoyed by oil and gas companies to help ease the cost of living for households across the UK. The tax will be phased out when oil and gas prices return to historically normal levels.

Chancellor Rishi Sunak’s levy brings in funds from the huge ‘windfall’ profits oil and gas companies have recently reported. The record profits have come about not because of sound strategic choices, rather the firms are beneficiaries of the soaring energy prices caused by the war in Ukraine and an increase in demand as the world surfaces from the Covid pandemic.

A windfall tax on oil and gas profits… How does it work exactly?

Energy companies will pay a further 25% on their existing taxes, taking the tax on their record profits to 65%. It’s estimated the levy will raise £5bn in 12 months, which will contribute to the government’s temporary cost of living support package for the most vulnerable households. 

To address the cost-of-living crisis, 8 million low income households in the UK will receive additional support of at least £1,200 this year, of which £400 will contribute to the Winter Fuel Payment. Furthermore, every household in the UK will be given a £400 discount on their energy bills later this year. 

So, struggling households get temporary relief from soaring energy prices. Energy companies get to keep a (smaller) percentage of the ‘extraordinary’ profits… So far so straightforward? Not quite. 

Incentivised reinvestment in UK oil and gas production 

As a sweetener the Chancellor has attached an 80% investment allowance to the windfall tax, almost doubling the tax relief available to oil and gas firms. This means tax savings of 91p for every £1 reinvested into oil and gas production. And the more a company reinvests in oil and gas extraction in the UK, the less tax that company will pay. As Sunak puts it, this is “a new and significant incentive to reinvest their profits” in the UK.  

And this is where several opposing groups of critics chime in. What exactly does the windfall tax announcement mean for investment in renewables? What of industry fears that investment in the UK Continental Shelf might now fall away? And are there implications for jobs in the energy supply chain?

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Importance of a stable environment for long-term investment

The government “has been clear it wants to see the oil and gas sector reinvest its profits to support the economy, jobs and the UK’s energy security”, however energy sector firms including giants BP, Shell are saying they will now reassess investment in the UK.

When the Energy Profits Levy was first mooted BP had originally stated that any windfall tax wouldn’t impact on the oil major’s planned UK investments. The company has since said that it will review the tax impact on its investment plans in the North Sea.

Shell, while initially supportive of the tax, emphasised the importance of a “stable environment for long-term investment”, saying, “the levy creates uncertainty about the investment climate for North Sea oil and gas for the coming years”.

And Deirdre Michie, Offshore Energies UK’s (OEUK) chief executive has warned that unpredictability is likely to undermine investor confidence

Low investor confidence may impact on new projects, with a knock-on effect on jobs

Windfall tax consequences won’t just hit the oil and gas operators. No investment in energy sector projects also means a potential negative impact on jobs. 

The repercussions would be felt throughout the oil and gas sector supply chain. Lack of investment certainty means up to 200,000 people in oil and gas services, manufacturing and support businesses could face job insecurity

One step forward, two steps back in energy transition investment?

Where does Sunak’s investment allowance leave net zero? The tax offset only applies to investment in the oil and gas sector, meaning there is no tax relief for investment in clean energy. 

The Energy Profits Levy comes just weeks after the government reiterated its commitment to energy transition with its Energy Security Strategy. The strategy states that 95% of electricity will be produced from low carbon sources by 2030, with offshore wind and nuclear power playing a central role in achieving that goal.

Clean energy firms and climate campaigners are frustrated about the missed opportunity to invest in energy efficiency projects, infrastructure and crucial National Grid network upgrades, and supply chains supporting offshore wind and clean energy projects. 

Furthermore, the OEUK’s Deirdre Michie and trade body Energy UK have commented that the levy will likely deter companies from investing in the UK renewables sector.

To guarantee energy security and meet net zero commitments, urgent investment is needed in projects to push forward energy transition and decarbonisation. Future investment uncertainty in renewables and energy transition projects will only compromise the UK’s net zero commitments

Much-needed financial relief is being redirected to those who need it, but this is only a sticking plaster solution. As with the Energy Profits Levy, longer term planning is in short supply.

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